Tuesday, 4 November 2008

The futility of trying to spend your way out of recession

Brown and Darling are about to abandon their so-called fiscal rules and increase government borrowing. They think that they can avoid a recession by maintaining a high level of aggregate demand.

This spend-your-way-out-of-recession has been tried many times before. In fact, it was tried only a few months ago by Bush. Under his fiscal stimulus package, every taxpayer in the US received a cheque of a couple of hundred dollars from the tax service. The idea was that people would go out and spend the money as soon as they received it.

Unfortunately, it didn't quite work that away. Here are a couple of charts that illustrated what happened. The first chart tracks personal disposable income. The fiscal stimulus package is clearly seen as a blip during the second quarter of 2008.

We can also see the stimulus package in the US savings rate. Rather than spending the cheque, most people actually saved it.

What happened to household expenditure? In real terms, it has been falling for a couple of months.

Declining consumption expenditure pushed economic growth into negative territory. Third quarter GDP data confirmed that the US economy was contracting and settling into a prolonged recession.

The failure of the fiscal stimulus package should be no surprise. Most taxpayers understood that the cheque was paid for by additional borrowing, and that eventually, they would have to pay the cheque back in the form of higher taxes in the future. Therefore, most Americans did the sensible thing and saved the money.

It would be no different here. Brown and Darling are already building up a huge fiscal deficit for 2008 and an even bigger one for next year. Eventually, this hole in the government accounts will have to be covered by higher taxes. Everyone knows this, and will act accordingly.

This should be no surprise to anyone with even a passing knowledge of UK economic history. During the 1970s, both Labour and Conservative governments tried to spend their way out of trouble. The end result was rising inflation, recession and rising unemployment.

14 comments:

I expect the pound to collapse and the IMF to be called in. The past decade of GDP growth has been fuelled by debt and is thus fake. As the Debt Junkies go cold turkey the Service Sector will collapse and a vicious spiral will start. Unemployment will rocket.

Our economy is built on three pillars:

1. The City - is bust.2. Property Speculation - is crashing.3. The State - is skint.

My prediction is this: basic tax rate up by 3-4, possibly 5p in the £, top rate up 10p in the £, VAT up to 20%, and probably a sneaky couple of pence on National Insurance payments (at tax by any other name) in order to pay for the yawning gap between revenue and spending. Labour will refuse to face the deficit before an election so poor old George Osbourne will have to bite the bullet in his first budget (an emergency one I suspect) and hope people remember who got us into this hole.

In the U.S., the 2008 stimulus checks served two additional purposes. First, they were a furtive way of increasing deposits in banks. Second, the Banana Republicans hoped to garner some votes. Too little too late on both counts.

I could not care less what the sad US economy or electorate is doing. It's time the UK economy stood again on it’s own merits. In the future we need to make ourselves more immune from their financial system.

I think you are right about higher taxes and higher inflation. It’s sad that people who tried to save for a house will now face a different battle of effectively higher living costs and eroding of their savings.

It is me again. I just reread your piece and I am grateful too, to have the opportunity.I am sure when you look at your piece again you would agree that you have been a tad overgenerous to UK folk."even a passing knowledge of UK economic history"?!? How about -zero- knowledge... How about not even managing to pass GCSEs. How about the Sun being the most popular paper.I could go on.... The average punter in the street is as thick as two short planks and we are in this situation precisely because of their ignorance, which will continue irrespective of the economic outlook.

Great article Alice, I too expect the next move to be a post election lurch in higher taxation. The tax and spend mistakes of the 1970's are all being played out again, only this time Alistair Darling is Chancellor instead of Denis Healey.

It seems that Labour are great at the promises during the good times, but lurch right back to their old habits as soon as the pressures on.

It wouldn't be so bad trying to run the Keynesian economic model if they would only give it a proper chance. Under the Keynesian model they where meant to build up huge tax reserves during the good times, and its this budget surplus that can now be harnessed to increase government spending.

This method differs greatly from the 1970's reality of borrowing to spend your way out of trouble. It was this practice that Thatcher smashed, and made Gordon Brown promise to only ever spend to invest.

Fitting I suppose that he should come full circle, and be the one to lead the Labour back there again.

Agree with the post and I like the clear correlation in the first two graphs.

"high level of aggregate demand"

This is the classical Keynesian conceit of pretending that demand = money. Supply IS demand. My demand for your goods is my supply of my own goods that I can trade for them. Money is just the intermediary. Therefore printing / borrowing money DOES NOT increase aggregate demand, it merely creates the illusion of increase.

Stupid friggin Keynesians. But then again, their whole scam is about the economics of illusion.

As for why are Brown and the gang giving it a try. Well, that's obvious. The taxation hurts a different group to the one the spending benefits. It's like the old joke "I have two apples, you have none, but we average one each".

What amazes me is that the UK population are so bloody thick...I mean that Brown's popularity has increased recently because people think that he is the saviour of the UK economy.Anyone with an IQ greater than 2 should realise that it was BROWN that got the UK into the mess we are now.Brown blames "world events" and the "US sub-prime" market for our troubles, but it was BROWN who set up the ineffective FSA, sold off gold reserves, gave the BOE independence (yeah right !) and encouraged reckless lending/low interest rates.Come on people - wake up and THINK FOR YOURSELVES !!!Miracle economy eh... the only miracle is that so many people actually believed it to be one !!!

mark, you think that there is no reason he keeps harping back to "Black" Wednesday? Or high interest rates? Or starts every sentence with "This crisis, which started in the US,...." or "***global*** recession"?

Anonymous - yup I saw the video and sadly it is true... people are thick !!!Suppose when the nanny state has rules for everything then people don't have to think any more.I saw through Blair's spin rubbish and Gordon Brown's sham "miracle" economy years ago but others obviously didn't.In 2005, people were feeling just "too wealthy" NOT to vote for anyone else - mugs I say !